A Critical Review of the IMF's Tools for Crisis...

4/2012Discussion Paper

A Critical Review of the IMF's Tools for Crisis Prevention Roberto Marino / Ulrich Volz

A Critical Review of the IMF’s Tools

for Crisis Prevention*

Roberto Marino / Ulrich Volz

* Parts of the paper were written while the first author was a Senior Visiting

Researcher at the German Development Institute. The authors are grateful

for the very helpful comments received from Joshi Bikas, Julia Leininger,

Maris Leemets, Julie McKay, Frank Moss, Carlos Perez-Verdía, Raymond

Ritter, Birgit Schmitz, Ted Truman, Peter Wolff, Regine Wölfinger, Gerardo

Zuñiga and at a seminar presentation at the European Central Bank. Roberto

Marino thanks the German Development Institute for its hospitality and sup-

port. The views expressed in this paper are our personal views and do not

necessarily reflect the views of the Mexican government.

Bonn 2012

Discussion Paper / Deutsches Institut für Entwicklungspolitik

ISSN 1860-0441

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The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed biblio-

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ISBN: 978-3-88985-547-3

Roberto Marino is a Special Representative for the Mexican Presidency of the G20, Secretaría de Hacienda y Crédito Público de Mexico.

E-mail: [email protected]

Ulrich Volz is a Senior Researcher at the German Development Institute / Deutsches Institut für Entwick-

lungspolitik (DIE).

E-mail: [email protected].

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Abstract

Against the backdrop of the International Monetary Fund’s (IMF) increasing focus on cri-

sis prevention measures and the G20’s discussion of “global safety nets”, this paper analy-

ses the IMF’s tools for crisis prevention, with particular emphasis on the recently devel-

oped Flexible Credit Line (FCL) and Precautionary Credit Line (PCL). The paper reviews

why it took the Fund so long to develop crisis prevention facilities that would find sub-

scribers and scrutinises initial experiences with the FCL and PCL. Moreover, it discusses

the systemic implications of and problems associated with such crisis prevention facilities

and examines why only so few countries are using these facilities thus far. Based on this

analysis, it offers policy recommendations for the development of the IMF’s crisis preven-

tion facilities.

Contents

Abbreviations

1 Introduction 1

2 IMF surveillance 3

3 Crisis prevention facilities of the Fund 5

4 Experiences with the FCL and PCL 12

4.1 Experiences with the FCL 12

4.2 Experiences with the PCL 24

5 Problems and concerns with the Fund’s precautionary facilities 25

5.1 Why are more countries not taking advantage of the Fund’s 25

precautionary facilities?

5.2 Further problems with the Fund’s precautionary facilities 29

6 Conclusions and recommendations 32

Bibliography 35

Figures

Figure 1: Effect of FCL announcement on Mexican 20

macro and financial indicators

Figure 2: Effect of FCL announcement on Colombian 21


Figure 3: Effect of FCL announcement on Polish 22


Figure 4: Effect of PCL announcement on Macedonian 23


Tables

Table 1: FCL arrangements to date 13

Table 2: Key economic figures for Colombia, Macedonia, 16

Mexico and Poland

Abbreviations

CCL Contingent Credit Line

CEMBI Corporate Emerging Markets Bond Index

CMIM Chiang Mai Initiative Multilateralisation

DDO Deferred Drawdown Option

DPL Development Policy Loan

EMBIG Emerging Markets Bond Index Global

EWE Early Warning Exercise

FCL Flexible Credit Line

FSAP Financial Sector Assessment Programmes

GDP Gross domestic product

GFSR Global Financial Stability Report

IMF International Monetary Fund

IMFC International Monetary and Financial Committee

MAP Mutual Assessment Process

NAB New Arrangement to Borrow

PCL Precautionary Credit Line

PLL Precautionary Liquidity Line

RAL Reserve Augmentation Line

RFA Regional Financing Arrangement

ROSC Reports on Observance of Standards and Codes

SDDS Special Data Dissemination Standard

SDR Special Drawing Rights

SLF Short-Term Liquidity Facility

STFF Short-Term Financing Facility

WEO World Economic Outlook

A Critical Review of the IMF’s Tools for Crisis Prevention

Deutsches Institut für Entwicklungspolitik / German Development Institute (DIE) 1

1 Introduction

The international financial system has been shaken by a number of crises over the last

three decades. Some had a systemic dimension while others were confined to specific

geographic regions or individual countries. Until the eruption of the 2008 crisis the gen-

eral perception was that crises would occur mainly in developing and emerging market

economies.

While the trend towards globalisation has produced many benefits, it has also meant that

the world’s financial system has become more complex, with a growing number of major

players who are capable of placing greater stress on the system through their domestic

policies. The growing interconnectedness of economies in trade and finance means that

problems in one country can easily be transmitted to other countries. The cost and fre-

quency of crises has increased. Therefore, under these circumstances it is important to

improve the international toolkit for crisis prevention. The goal should be to act pre-

emptively in order to ensure the implementation of policies that prevent the build-up of

unsustainable imbalances and make adequate resources readily available for dealing with

episodes of contagion in the financial markets.

Historically, the International Monetary Fund (IMF) has been more occupied with crisis

resolution than crisis prevention. While the creation of crisis prevention facilities has been

discussed since the early 1990s, it took the Fund’s Executive Board until March 2009 to

launch a facility – the Flexible Credit Line (FCL) – with ex ante conditionality for mem-

ber countries with very strong economic fundamentals and institutional policy frameworks

that would find subscribers. Shortly thereafter, in August 2010, the Fund launched the

Precautionary Credit Line (PCL) for countries that do not qualify for the FCL due to mod-

erate vulnerabilities in spite of sound fundamentals and policy track records. The creation

of these two facilities marked a new era in the Fund’s approach to crisis prevention. At the

Cannes Summit in November 2011, the G20 leaders underlined their determination “to

continue [...] efforts to further strengthen global financial safety nets and [...] support the

IMF in putting forward the new Precautionary and Liquidity Line (PLL) to provide on a

case by case basis increased and more flexible short-term liquidity to countries with

strong policies and fundamentals facing exogenous shocks” (G20: §10). Shortly after the

Cannes Summit, the IMF launched the PLL as an expansion of the PCL as a means of

providing short-term liquidity support over the course of six months.

Against the backdrop of the Fund’s increasing focus on crisis prevention measures and the

discussion of global safety nets among the G20, the objective of this paper is to analyse

the IMF’s tools for crisis prevention, with a particular emphasis on recent experiences

with the FCL and the PCL. The paper seeks to answer the following questions: Why did

IMF crisis prevention facilities take so long to develop? What initial experience has been

gathered with the FCL and PCL? What are the systemic implications of and problems as-

sociated with such crisis prevention facilities? Why are so few countries using these facili-

ties, and how can the FCL and PLL – which has now replaced the PCL – be made more

attractive?


2 Deutsches Institut für Entwicklungspolitik / German Development Institute (DIE)

The paper is structured as follows. The next section (Section 2) provides a brief descrip-

tion of the IMF’s work on helping to prevent crises through its surveillance work. Section

3 then reviews the development of the Fund’s crisis prevention instruments between the

time of the first discussions in the Executive Board in 1993 and the creation of the FCL

and PCL in 2009 and 2010, respectively. The chronology of the debate on crisis preven-

tion facilities at the IMF highlights the many difficulties that were encountered before the

creation and use of these facilities. The main creditor countries of the IMF were hesitant to

create facilities that committed a large amount of resources up front without the traditional

ex post conditionality and no phasing of the drawings. For their part, the potential users of

the crisis prevention instruments were cautious about using them due to the stigma at-

tached to the use of traditional IMF facilities. In general, potential users had relatively

comfortable access to financial markets until 2008 and did not believe that the design of

the instruments offered by the IMF at the time matched the features that they required

from a crisis prevention, insurance-type, instrument. The 2008 financial crisis can be con-

sidered as the turning point in the debate for the creation of crisis prevention instruments

in light of the need to use the entire available arsenal to halt contagion and create condi-

tions for emerging from the crisis coupled with the need of certain countries for this type

of instrument.

Section 4 takes stock of initial experiences with the FCL and PCL. The motivation of

Mexico, Colombia and Poland – the first three countries to seek an FCL arrangement – for

using the FCL is analysed, as well as the immediate impact of the FCL on their macroeco-

nomic and financial variables. We conclude that the FCL has been a very successful in-

strument from the view point of the three pioneer countries, since they have on two occa-

sions renewed the FCL (with the most recent renewal spanning a two-year period), and

that the FCL has helped to fortify their reserve position and creditworthiness. We also put

emphasis on the benefits of the FCL for the IMF as an instrument that strengthens its sur-

veillance practices, generates positive externalities in terms of a healthier world economy,

and contributes to its finances. Although experiences gathered to date with the PCL are

too recent for forming a comprehensive judgement, the fact that Macedonia drew on the

PCL only a few months after the arrangement had been agreed on may lessen confidence

in the PCL.

Subsequently, Section 5 discusses the systemic implications of and problems associated

with such preventive facilities and scrutinises the probable causes behind the lack of de-

mand for this instrument by other countries and elaborates some proposals for promoting

use of the FCL and PLL, such as better IMF outreach, longer duration for the facility, and

reduction of the commitment fees. We address the issue of sufficiency of IMF resources if

more demand for the FCL and PLL should arise and propose the use of contingent com-

mitments to fund the IMF through a strengthening the New Arrangement to Borrow

(NAB) or by allowing the Fund to borrow in capital markets. Additionally, we explore the

possible synergies between the IMF’s crisis prevention facilities and regional financial

arrangements. Section 6 offers concluding remarks and policy recommendations.



2 IMF surveillance

Surveillance is the IMF’s quintessential crisis prevention tool. As the Fund itself points

out, “by virtue of its universal membership” it is “uniquely placed to monitor and assess

economic and policy spillovers across countries, advice on how to achieve global eco-

nomic and financial stability (a global public good), and serve as a forum where members

discuss each other’s policies and collaborate” (IMF 2010b).

Surveillance seeks to detect flaws in members’ policies both at the country level through

the annual Article IV consultations and at the global level through analysis in the context

of publication of the World Economic Outlook (WEO). Its goal is to promote balanced

growth and exchange rate stability by ensuring that countries do not implement policies

leading to unsustainable financial or trade imbalances. As recently as 1999 the IMF

strengthened its surveillance of financial sector issues with the Financial Sector Assess-

ment Programmes (FSAP), under which it carries out comprehensive and in-depth analy-

sis of an individual country’s financial sector every five years together with the World

Bank. In 2002, the Fund launched the Global Financial Stability Report (GFSR), pub-

lished twice a year, in order to focus more carefully on financial flows and their sustain-

ability. Additionally, in November 2008, the G20 asked the IMF and the Financial Stabil-

ity Board (FSB) to collaborate on regular Early Warning Exercises (EWEs).

The efficacy of IMF surveillance is invariably questioned when crises erupt. In the after-

math of a crisis, the IMF typically seeks ways to strengthen surveillance in order to mini-

mise the risk of the outbreak and spread of crises in the future; which sometimes has given

rise to allegations that the Fund was trying to fight the previous crisis. For instance, after

the Mexican “tequila crisis” of 1994, the IMF concluded that more effective surveillance

required an improved collection of data, a more continuous policy dialogue, a better-

focused surveillance of countries at risk and of where financial tensions were most likely

to have spillover effects, and more candidness in surveillance. However, then-Managing

Director Camdessus (1995) pointed out very clearly the main problem with all the propos-

als for strengthening surveillance in a statement which is still valid more than fifteen years

later: “I fear that implementing it [stronger surveillance] will not be a straightforward

matter: experience shows that while countries tend to be very eager for surveillance over

others, they are less keen on surveillance over themselves. It will be a critical challenge

for international policy cooperation and for the IMF.”

The situation has not changed substantially over the years, and the Fund has often found

itself accused of “sleeping at the wheel” (Goldstein / Mussa 2005), even when it has actu-

ally tried to address vulnerabilities. In order to improve the effectiveness of surveillance in

light of the threat posed by global imbalances, the IMF in 2006 started to experiment with

ways to deal with this problem. In particular, it launched its multilateral consultations on

global imbalances. The aim was to identify spillover effects and serve as a mechanism for

internalising the benefits of collective action. The IMF (2006b) hoped that its multilateral

consultations would “enable the Fund and its members to agree upon policy actions to

address vulnerabilities that affect individual members and the global financial system, and

[...] help policy makers to show that the measures they propose will be matched by meas-



ures taken by others, with benefits to all. Each multilateral consultation will focus on a

specific international economic or financial issue and directly involve the countries that

are party to that issue”. As history has shown, the multilateral consultations did not have

any positive results in terms of crisis prevention, given the unwillingness of (large) mem-

ber countries to adhere to IMF policy advice resulting from the multilateral consultations

process.

The 2008 crisis led to a great deal of soul-searching within the IMF and in the interna-

tional community on ways to improve surveillance (e.g., Aiyar 2010). Accordingly, the

IMF has pushed strongly since that time for finding ways to strengthen multilateral sur-

veillance and its integration with bilateral surveillance. In particular, the IMF (2011a) ex-

pressed its ambition to carry out “better assessments of policy spillovers across countries;

[i]mprove the understanding of the real sector’s linkages with the financial system

(macro-financial linkages), as well as mapping the connections in the global financial

system; [s]trengthen financial sector surveillance, including by making this more of a fo-

cus of bilateral surveillance and making the financial stability assessment under the FSAP

mandatory for systemically important financial centerscentres; and [m]ake sharper risks

assessments through the Early Warning Exercise and the vulnerability exercises, thereby

fostering more candid policy dialogue with country authorities.” Further efforts to im-

prove surveillance and boost the crisis prevention toolkit of the IMF are certainly very

important. Several authors have put forward suggestions in this regard (e.g., Truman

2010a).

Additionally, the huge costs associated with the 2008 crisis have prompted the G20 to

make efforts at improving surveillance through enhanced policy cooperation. In order to

strengthen policy cooperation with the aim of reducing global imbalances and to exert

more peer pressure for improving the effectiveness of surveillance, the G20 launched the

Mutual Assessment Process (MAP) at the Pittsburgh Summit in September 2009 (cf. IMF

2011b). Realising that the interconnectedness of global trade and financial markets in the

twenty-first century will make effective international macroeconomic coordination more

important than ever before, the G20 leaders asked the IMF to support implementation of

the MAP in tracking progress in reaching the goals established in their “framework for

strong, sustainable, and balanced growth”. In particular, the IMF was mandated to estab-

lish consistency checks between individual country policies and their results at the global

level, and to ensure that individual country policies do not have unintended negative re-

percussions on other countries and the world economy. The MAP thus seeks to address

collective action problems while avoiding a form of non-cooperative equilibrium that

would entail substantial welfare costs as a result of recourse to “currency wars”, beggar-

thy-neighbour policies, protectionism, and in general, nationalistic reactions that are self-

defeating in the aggregate.

However, even with improved IMF surveillance at the national and global level, there is

no doubt that crises will continue to occur time and again. Accordingly, the IMF needs to

complement its crisis prevention toolkit with financial instruments for effectively warding

off contagion, bandwagon effects and herd behaviour in financial markets. Crisis preven-

tion facilities like the FCL and the PCL naturally complement the Fund’s surveillance



activities since they are tailored to promote sound macroeconomic policies in eligible

countries.

3 Crisis prevention facilities of the Fund

Initial discussions

The international community and the IMF have struggled for years to create a crisis pre-

vention facility. As early as 1993, the IMF started to study the possibility of creating a

contingent facility for countries which, although economically solid, might be the object

of speculative attacks in a world in which capital market integration was gaining force. In

effect, the IMF discussed the creation of the Short Term Financing Facility (STFF) in

1993 with the objective of “helping members with strong policies deal with financial market

volatility” (IMF 2003a, 4). The facility was “aimed at Fund members particularly vulner-

able to large swings in capital movements induced by external conditions.” (IMF 2003a, 4)1

The proposed STFF did not materialise due to concerns by many members of the Execu-

tive Board about committing the Fund’s resources without the usual phasing and condi-

tionality attached to Fund programmes. It was feared that the IMF would not be capable of

distinguishing countries under speculative attack due to contagion and requiring mere li-

quidity support from countries facing external disequilibrium and requiring adjustment on

the part of the respective country. According to the IMF (2003a, 4), “[t]he proposal was

not adopted because of a range of concerns about the difficulty of assessing when markets

have misjudged a particular country’s policy stance, the risks of using Fund resources in

the context of severe financial pressures without a framework of conditionality, as well as

concerns about substituting Fund resources for other available short-term facilities.”

These three issues, which we call the eligibility, the conditionality and the “sufficiency of

resources” problem, were at the centre of discussions regarding the creation of a crisis

prevention instrument at the IMF.

Another concern that was prominent not only in the STFF discussions but also invariably

a factor in the discussion of crisis prevention instruments was moral hazard. The IMF de-

fines moral hazard “in the context of Fund financing” as “the risk that the availability of

Fund financing may encourage reckless behavior among borrowing members and their

creditors. It can arise if Fund involvement shields either the debtor or the creditor from

facing possible negative consequences of their actions” (IMF 2006a, 19). In the view of

moral hazard “vigilantes”, any form of automatic access to IMF resources would assur-

edly worsen the moral hazard problem.

Mexico’s financial and balance of payments crisis at the end of 1994 and the beginning of

1995 highlighted the importance of capital account issues for crisis prevention purposes.

Indeed, Michel Camdessus (1995) described the Mexican crisis as the first crisis of the

1 See also IMF (1994a, 1994b).



twenty-first century, in the sense that it was “the first major financial crisis to hit an

emerging market economy in the new world of globalized financial markets”. Arguably,

the IMF at the time had not adapted its toolkit to meet the challenges of this new world.

The Contingent Credit Line

The idea of a Contingent Credit Line (CCL) resurfaced in the fall of 1998 after the Asian

financial crisis. At that time, the issue of contagion was central, since the Asian crisis was

spreading to many countries with fundamentally solid economies. Market pressures were

emanating from this contagion and from bandwagon effects and herd behaviour rather than

from weak domestic policies. Therefore, an IMF instrument to reassure markets of the

strength of economic policies in many emerging markets was actively sought. The objective

of this instrument was that financial markets would be able to differentiate between the risks

faced by different economies and would not lump all emerging markets together in their risk

assessment processes when making their investment decisions. Indeed, the IMF’s concern

(2003a; 5) “was that the globalization of capital markets coupled with swings in investor

risk appetite may lead to capital market pressures not resulting from weaknesses in domestic

policies but from “contagion”.” Against this backdrop, the Fund devised a facility that was

supposed to provide ex ante assurances of appropriate financial support, thereby helping to

boost market confidence, and reduce the probability of a crisis. As a result, the CCL was

designed to “provide assurances to members with demonstrably sound policies that Fund

resources would be readily available in the event of financial market pressures due to exter-

nal events” while creating “further incentives for the adoption of sound policies and

stronger institutional frameworks” (IMF 2003a, 5) for the member countries.

The CCL was launched in April 1999 with a life cycle of two years and a review of its

effectiveness after one year, and with unique features that distinguished it from regular

Fund facilities (cf. IMF 1999). Contrary to regular IMF facilities, it did not contain pro-

gramme monitoring and conditionality on for meeting various performance criteria. In-

stead, it had what is called ex ante conditionality or qualification requirements. Access to

Fund resources was up-front instead of the usual phased access dependent on achieving

the programme’s targets. The CCL offered automatic access to resources without the need

for a formal review process. The aim of the CCL was firstly to provide incentives to coun-

tries to maintain strong macroeconomic policies and secondly to send strong positive sig-

nals to markets regarding the creditworthiness of the respective countries. It was hoped

that this would counteract the stigma that countries tend to use IMF resources when facing

severe imbalances and the need to put their financial house in order. The IMF (1999) press

communiqué emphasised the preventive nature of the CCL and characterised it as a

“measure intended solely for members that are concerned with potential vulnerability to

contagion, but are not facing a crisis at the time of commitment”, in contrast to other fa-

cilities, such as the Supplemental Reserve Facility, which are to be used “by members

already in the throes of a crisis.”

As it turned out, there were no requests for CCL resources as originally designed. The mem-

ber countries were still concerned with the negative signal to markets that usually accompa-



nied an arrangement with the IMF. Moreover, several countries were concerned with the

negative domestic signal that using an IMF facility would convey. Additionally, the eligibility

criteria were very stringent, and only a handful of countries were seen as potential candidates.

Many of the potentially eligible countries had begun to take action to “self-insure” against

contagion through substantial reserve accumulation, others believed that their flexible ex-

change rate policy was a good buffer against speculative attacks, and still others saw strength

in regional arrangements that would operate under conditions of stress in financial markets.

Another concern was the so called “exit problem”. It was not clear to the members how

the market would interpret the termination of a CCL. Many thought that markets would

suspect that a country was exiting from the CCL because it no longer qualified for the in-

surance, and not because it did not need the insurance any more. This meant that once you

entered into a CCL you were stuck with it. This was the case even though qualification

requirements were very clearly spelled out under the CCL, and presumably markets could

in effect verify why a country was exiting from the facility.

Another fact that reduced the attractiveness of the CCL was that it lacked complete

“automaticity”. The Board had to give its approval prior to a purchase. That is, the re-

sources committed under the CCL could be refused when they were actually needed by the

member country. This uncertainty was seen by many potentially eligible countries as an

undesirable feature of the CCL. In general, there was a perception of rigidity in terms of

eligibility, activation and disbursement. Of course, all of these rigidities had been intro-

duced to the CCL to give assurances to IMF board members who remained sceptical of the

merits of a CCL, believing that the CCL should have adequate safeguards for the use of

IMF resources. Other objections to the CCL were in the financial area: the commitment

fees was considered too high; the 12-month duration of CCL was considered too short,

and the access amounts were considered too low.

Since there was no demand for the CCL, the facility was cancelled in November 2003. At

the time, the IMF (2003b) stated: “The fact that no member chose to use the CCL, despite

some general interest, reflects both technical issues connected to the design of such a con-

tingent facility, and the ongoing strengthening of the international financial system. Many

emerging market economies have reduced their vulnerability to shocks through reserve

accumulation, the adoption of flexible exchange rates, and other reforms.” However, the

search for an effective crisis prevention instrument continued. The IMF’s medium-term

strategy in 2006 again included the search for “a new vehicle for the provision of high

access financing for crisis prevention […] targeting emerging market countries that have

strong macroeconomic policies, sustainable debt, and transparent reporting and that are

making progress in addressing remaining vulnerabilities to shocks” (IMF 2006a, 1).

The Reserve Augmentation Line

The Reserve Augmentation Line (RAL) incorporated the views from official sector repre-

sentatives and market participants on ways to make a crisis prevention instrument more

appealing. It sought to address many of the concerns in terms of design that had made the

CCL unattractive. In particular, it proposed important changes in terms of the qualification



framework, monitoring structure, access levels, and financial terms. As was the case dur-

ing the initial discussions on crisis prevention facilities, the idea was that the RAL should

be useful for individual countries and for the system as a whole. The challenge thus was to

strike the right balance between adequate insurance and moral hazards.

At the time of the discussion of the RAL in March 2007, the situation of the world econ-

omy still appeared relatively stable; there was no urgency to reach agreement on the sev-

eral contentious points of the design of the RAL. This lack of urgency is manifested in the

IMF’s Executive Board conclusions with respect to the RAL. According to the records,

“some Directors remain[ed] skeptical about the need for and the viability of a new liquid-

ity instrument, or [felt] that the currently proposed formulation of the RAL is unlikely to

provide meaningful and reliable support for crisis prevention. [...] the staff has made good

progress in addressing the concerns and suggestions made by Directors at the August

seminar, but underscored the need to improve and clarify further various design issues of

a possible RAL” (IMF 2007). It was agreed that IMF staff would prepare a follow-up pa-

per building on areas where there was broad agreement and with proposals for bridging

areas where more progress needed to be made.

The Short-Term Liquidity Facility

The collapse of Lehman Brothers in September 2008 and the unfolding global financial

crisis created the sense of urgency that had been missing before about establishing the

RAL. The crisis caused a significant drying up of market liquidity worldwide, and many

emerging market economies, even those that had maintained sound macroeconomic

frameworks, were negatively affected. In this context, the Short-Term Liquidity Facility

(SLF) was launched at the end October 2008 to help countries that despite strong initial

macroeconomic positions and policies were facing short-term liquidity pressures in the

midst of the most severe turmoil to hit global capital markets in decades.

Dominique Strauss-Kahn, then Managing Director of the IMF, highlighted the IMF’s

commitment “to promoting a coordinated and cooperative approach to dealing with the

current crisis. […] Exceptional times call for an exceptional response […]. The Fund is

responding quickly and flexibly to requests for financing” (IMF 2008a). Indeed, the crisis

led to a rapid establishment of the SLF in order to help improve liquidity conditions in

global financial markets and avoid the spread of contagion from the epicentre of the crisis

towards fundamentally sound economies with a strong macroeconomic framework.

The design of the SLF was based on several broad principles (cf. IMF 2008b): (i) strict

eligibility of only “those countries facing short-term, self-correcting balance of payments

pressures arising from external developments rather than from domestic policy weak-

nesses” (IMF 2008b, 3); (ii) quick creation with “a premium on speed and simplicity”

(IMF 2008b, 3); (iii) large access with quick and streamlined disbursement conditions; (iv)

no mission required prior to Board approval; (v) only ex ante conditionality; (vi) participa-

tion restricted to countries with very strong policies and fundamentals, sustainable public

and external debt, and a history of implementing sound policies in order to safeguard Fund



resources; and (viii) a strict limit to the period over which resources can remain out-

standing.

No country used the SLF, and it was discontinued with the introduction of the Flexible

Credit Line (FCL), which represented an improvement over the SLF. Potential users of the

SLF still considered that its capped access and short repayment period, as well as the in-

ability to use it on a precautionary basis, were drawbacks for using the facility. It should

be noted that several potential users of the SLF chose to arrange bilateral facilities from

other countries rather than go to the IMF. Indeed, around the same time, the U.S. Federal

Reserve established temporary reciprocal currency arrangements (swap lines) for 30 bil-

lion dollars with Banco Central do Brasil, the Banco de México, the Bank of Korea, and

the Monetary Authority of Singapore, respectively.

The Flexible Credit Line

The unprecedented magnitude of the global financial crisis prompted a quick rethinking of

the need to revamp the IMF’s toolkit and led to a tripling of Fund resources, a substantial

allocation of special drawing rights, and the creation of the FCL. All of these actions had

been unthinkable for the international community just a few years prior to the crisis.

The FCL was launched in March 2009 as an instrument for reducing the likelihood of a

crisis by boosting confidence in emerging market economies beset by severe turmoil in

global financial markets. By augmenting access to official liquidity, it was to be a means

of supplementing reserves at a time when markets were testing central banks’ resolve to

contain volatility in exchange markets. The objective was (and still is) to provide an effec-

tive alternative to costly self-insurance while reinforcing strong policies. Thus, creating

synergies between the liquidity and credibility effects of Fund support was a key feature of

the FCL (cf. IMF 2009a).

The G20 Leaders’ Summit in Washington in November 2008 can be seen as the moment

when the impasse for the creation of the FCL was finally broken. Countries that had been

very concerned with safeguarding the IMF’s resources at last agreed to introduce the

flexibility required by such an instrument. It is important to recall that several members of

the IMF’s Executive Board had strong concerns about the FCL, fearing that the ease of

access to it might induce a large precautionary use of Fund resources, thereby crowding

out lending for crisis resolution. Moreover, there was concern with the absence of limita-

tions on access, since this might lead to uneven treatment of members and reduce the pre-

dictability of Fund lending. Additionally, many were concerned that ex ante conditionality

might not provide adequate safeguards for the use of Fund resources. Lastly, many high-

lighted the moral hazard, arguing that the FCL might undermine incentives for undertak-

ing reforms or fully assessing risks.

Notwithstanding these concerns, the G20 Washington Summit Declaration of 15 Novem-

ber 2008 in effect committed the group to “[h]elp emerging and developing economies

gain access to finance in current difficult financial conditions, including through liquidity

facilities and program support” (G20 2008, 2). The Declaration also stressed the IMF’s



“important role in crisis response, welcome[d] its new short-term liquidity facility, and

urge[d] the ongoing review of its instruments and facilities to ensure flexibility.” (G20

2008, 2) The key word here was flexibility since this mandate led to the creation of the

FCL a few months later.

The FCL incorporated many of the design elements that several of the potential users had

been advocating: large and up-front access to Fund resources; no ex post conditionality; a

renewable credit line; a longer repayment period; no specific limit to the degree of access

to Fund resources; flexibility to draw on the credit line at any time; and the possibility of

treating it as a precautionary instrument (which was not the case under the SLF).

The IMF set very strict qualification standards in order to give adequate assurance to

members that Fund resources were safeguarded in spite of the added flexibility of the

FCL. These included “an assessment that the member (a) has very strong economic fun-

damentals and institutional policy frameworks; (b) is implementing – and has a sustained

track record of implementing – very strong policies, and (c) remains committed to main-

taining such policies in the future” (IMF 2009a). Moreover, the IMF explicitly spelled out

the criteria it would be using to evaluate whether a member country was eligible for FCL.

These included: (i) a sustainable external position; (ii) a capital account position domi-

nated by private flows; (iii) a track record of steady sovereign access to international capi-

tal markets at favourable terms; (iv) a reserve position that is relatively comfortable when

the FCL is requested on a precautionary basis; (v) sound public finances, including a sus-

tainable public debt position; (vi) low and stable inflation, in the context of a sound mone-

tary and exchange rate policy framework; (vii) the absence of bank solvency problems that

could pose the immediate threat of a systemic banking crisis; (viii) effective financial sec-

tor supervision; and (ix) data transparency and integrity (cf. IMF 2009b). However, coun-

tries need not show “[s]trong performance against all these criteria” – that is, the Fund

left room for flexibility (and interpretation) by taking into account “compensating factors,

including corrective policy measures under way” when assessing the criteria in the quali-

fication process (IMF 2009b).

On 30 August 2010, the IMF enhanced the FCL by providing more flexibility in terms of

access and length (cf. IMF 2010a). In particular, the duration of the credit line was dou-

bled to a two-year period, and the notional cap on access of 1,000 per cent of quota was

eliminated. Higher access and a longer duration for the FCL facility were introduced to

provide the necessary insurance against tail risks that persist for periods longer than an-

ticipated. This feature allows more time for shocks to dissipate and increases policy flexi-

bility. These enhancements have improved the FCL’s function as an increasingly attractive

substitute for reserves. The enhancement of the FCL was part of the Fund’s decisions to

“expand and reinforce [its] crisis-prevention toolkit and mark an important step in our

ongoing work with our membership to strengthen the global financial safety net” (IMF

2010a). Moreover, it affirmed that “[t]hese reforms come as the G20 has made the

strengthening of the global financial safety net an agenda item for its next meeting in

Seoul, Korea in November 2010” (IMF 2010a).



The Precautionary Credit Line

The Fund further enhanced its precautionary lending toolkit with the introduction of the

Precautionary Credit Line (PCL). The PCL was created with the aim of providing an ef-

fective crisis prevention window for member countries whose fundamentals were in an

intermediate range and hence did not qualify for the FCL. It seemed that countries in this

category would be the ones that would benefit most from a crisis prevention facility of this

type, since the confidence boosting effects and the incentive for pursuing strong policies

would operate most effectively under these conditions (cf. IMF 2006a). In effect, the PCL

was conceived as a way to tailor Fund conditionality to the particular strengths and fun-

damentals of member countries, and to put emphasis on ex ante conditionality. With the

PCL, the IMF sought to diminish the stigma prevalent in many countries regarding IMF

financing.

The PCL was also perceived as an insurance-type instrument that would encourage coun-

tries to take pre-emptive measures to avoid a crisis. Its design rewarded countries imple-

menting strong policies and targeted a broader spectrum of countries which are relatively

more vulnerable compared with those that qualify for the FCL. Nevertheless, to qualify for

a PCL a country must have a positive evaluation in five broad areas, namely (i) external

position and market access; (ii) fiscal policy; (iii) monetary policy; (iv) financial sector

soundness and supervision; and (v) data adequacy. The main attributes of the PCL are

“[s]treamlined ex post conditions designed to reduce any economic vulnerabilities identi-

fied in the qualification process, with progress monitored through semi-annual program

reviews” and “[f]rontloaded access with up to 500 percent of quota made available on

approval of the arrangement and up to a total of 1000 percent of quota after 12 months”

(IMF 2010a).

When the PCL took effect at the end of August 2010, Dominique Strauss-Kahn expressed

the hope that “[t]he enhanced Flexible Credit Line and new Precautionary Credit Line

will enable the Fund to help its members protect themselves against excessive market

volatility” (IMF 2010a).

The Precautionary and Liquidity Line

The PCL was replaced in November 2011 by the Precautionary and Liquidity Line (PLL),

which “builds on the strengths and broadens the scope” (IMF 2011n) of the PCL. The

PLL combines a qualification process similar to that for the FCL with ex-post condition-

ality intended at addressing vulnerabilities identified during qualification. The PLL was

launched against the backdrop of the European debt crisis, which created fears of financial

contagion across the eurozone and beyond, to include a shorter-term facility to support

liquidity over six months.

Under the PLL, countries can enter arrangements with a duration of either six months or

one to two years. The six-month PLL arrangement is accessible for countries with actual

or potential short-term balance of payments needs and can be renewed only after a two-

year “cooling-off period” from the date of approval of the previous six-month PLL ar-



rangement. Under the six-month PLL, countries can draw up to 250 percent of their quota;

higher amounts of up to 500 percent of quota are “available in exceptional circumstances

where the member country’s increased need results from the impact of exogenous shocks,

including heightened stress conditions” (IMF 2011n). Under PLL arrangements with a

duration of one to two years countries can access a maximum of 500 percent of their quota

for the first year and a total of 1,000 percent of quota during the second year.

4. Experiences with the FCL and PCL

4.1 Experiences with the FCL

First users of the FCL

Mexico was the first country to use the FCL in April 2009, followed by Poland and Co-

lombia in May. After more than fifteen years of struggling with the design of a crisis pre-

vention instrument, one had at last been put in place and was being used by Fund mem-

bers. When the IMF’s Executive Board approved Mexico’s FCL, John Lipsky, then the

First Deputy Managing Director of the IMF, called the approval (which was also the larg-

est financial arrangement in the Fund’s history at the time) “a historic occasion” and “the

consolidation of a major step in the process of reforming the IMF and making its lending

framework more relevant to member countries’ needs” (IMF 2009c).

In May 2009, at the time the FCL was approved for Poland and Colombia, the Executive

Board expressed its concerns about a possible further deterioration in the global economic

environment. When the IMF Executive Board approved the FCL to Poland, the Fund high-

lighted that it should contribute to boost market confidence and Mr. Lipsky stressed that

“[t]he FCL arrangement for Poland will also have a positive regional impact” (IMF

2009e). Upon approval of the FCL to Colombia, Mr. Lipsky highlighted the precautionary

nature of the instrument, the additional insurance provided by the FCL, and its “important

role in bolstering confidence in the authorities’ policy framework and strategy at a time of

heightened global uncertainty” (IMF 2009g).

These three pioneer countries (the “FCL3”) – all of which have renewed their respective

FCL arrangement with the Fund twice (cf. Table 1) – have provided an excellent test run

of the FCL. The FCL3 country authorities have stated that their objective of using the FCL

is to protect their economies from current tail risks due to the existing turbulence in global

financial markets. They believed that the large amount of resources committed by the IMF

under the FCL gave markets the necessary assurances that they would have the financial

wherewithal to confront extreme conditions in financial markets. Moreover, FCL3 country

authorities felt that the large up-front resources upon which they can draw without any

further conditionality under the FCL are in fact the best guarantee that these resources will

not need to be used. In effect, the signalling effect of a large treasure chest discourages



speculation against the currency of an FCL country. The three countries thus regard the

FCL as a considerable boost to their usable reserves.2

The results for these countries under the FCL can be used to analyse the strengths and

weaknesses of this crisis prevention instrument. In particular, they make it possible to

evaluate whether some of the FCL-related concerns mentioned above have materialised,

such as the stigma issue or the moral hazard problem. Additionally, the impact of the FCL

on national economies can also be assessed, including the market reaction, the impact on

reserve accumulation, and the question of whether strong policies have been reinforced.

The IMF’s Assessment of FCL qualification criteria

As with any such facility, the IMF staff must always prepare a report on the fulfilment of

the qualification criteria by the country applying for the FCL before the FCL can be dis-

cussed and approved by the Board. A summary of the IMF staff’s assessments of the

qualification criteria for the FCL3 countries is provided in the following. For an overview

of key economic figures of the FCL3 see Table 2.

(i) Sustainable external position: The IMF staff analysis of the external position of the

FCL3 was very positive when the initial arrangement was agreed. The evaluation docu-

ments highlighted the relatively low external debt levels of the FCL3 and the fact that the

current account deficits were at low and sustainable levels, financed largely by foreign

direct investment flows. Moreover, external debt sustainability analysis showed that the

external position of the FCL3 was robust when subjected to a variety of hypothetical

2 See IMF (2009d, 8); IMF (2009f, 13); IMF (2009h, 12).

Table 1: FCL arrangements to date

2009 2010 2011

Mexico 17 April

1,000% of quota

SDR 31.52bn

1 year

25 March

1,000% of quota

SDR 31.53bn

1 year

10 Jan

1,500% of quota

SDR 47.29bn

2 years

Poland 6 May

1,000% of quota

SDR 13.69bn

1 year

2 July

1,000% of quota

SDR 13.69bn

1 year

21 Jan

1,400% of quota

SDR 19.17bn

2 years

Colombia 11 May

900% of quota

SDR 6.97bn

1 year

7 May

300% of quota

SDR 2.32bn

1 year

6 May

300% of quota

SDR 3.87bn

2 year

Source: Compiled by authors with data from the IMF

Note: SDR stands for Special Drawing Rights



shocks. The Fund’s assessment in the subsequent renewals of the FCL in 2010 and 2011

basically corroborated that the FCL3 had continued to fulfil this criterion.3

(ii) Capital account position dominated by private flows: With respect to the capital ac-

count being predominantly composed by private flows, the analysis certified that for all

FCL3 the vast majority of capital flows originated in the private sector. The fulfilment of

this criterion was corroborated in the 2010 and 2011 renewals of the FCL.

(iii) Track record of steady sovereign access to international capital markets at favour-

able terms: With respect to access to international capital markets, the analysis was very

clear that the FCL3 were among those best rated in credit markets. In the case of Mexico,

the IMF (2009d, 12) pointed out that “Mexico is among the highest rated emerging mar-

kets, as has been reflected in a track record of low sovereign external borrowing spreads,

including during periods of stress such as during the 2001 recession”. In the case of Po-

land, it was highlighted that “[a]s recently as January 2009, Poland was able to issue

sovereign debt in international capital markets” (IMF 2009f). Even though Colombia

does not have an investment grade rating, the IMF analysis pointed out that even though

Columbia’s “sovereign debt rating is one notch below investment grade” its “sovereign

spreads and vulnerability indicators are similar to those of countries with higher credit

ratings” (IMF 2009h). The fulfilment of this criterion was confirmed in the 2010 and 2011

renewals of the FCL.

(iv) Relatively comfortable reserve position: With respect to reserves, the analysis high-

lighted that the FCL3 reserve levels were adequate for “normal” times. However, it also

pointed out that the environment of high volatility and global deleveraging called for an

increase in reserve backup, i.e. increased buffers, which could be provided by the FCL.

This assessment was repeated in the 2010 and 2011 renewals of the FCL.

(v) Sound public finances, including a sustainable public debt: With respect to public fi-

nances and the debt position, the IMF assessments pointed out that all FCL3 have a sus-

tainable public debt and a sound fiscal situation, in spite of the fact these countries had

recently increased their public debt levels as a consequence of weakness in their econo-

mies due to the global crisis in 2007 and 2008, and as a result of some fiscal stimulus pro-

vided to the economy. The IMF also highlighted the strong institutional setting that under-

pins the maintenance of fiscal responsibility. In the case of Mexico, the IMF (2009d)

stated that “[f]iscal policy is underpinned by the balanced budget rule as well as the au-

thorities’ commitment to keep the augmented public sector deficit (including development

banks and other levels of government) at a level that stabilizes the overall public debt.” In

the case of Poland, the IMF (2009f) stated that beyond a “strong commitment to the Maas-

tricht criteria, fiscal policy has been underpinned by the Polish Public Finance Act –

prompting corrective action when public debt reaches trigger levels of 50 and 55 percent

of GDP – and by the constitutional ceiling on public debt of 60 percent of Gross Domestic

3 See IMF (2010d); IMF (2010e); IMF (2010f); IMF (2011d); IMF (2011e) and IMF (2011f).



Product (GDP).”4 In the case of Colombia, the IMF (2009h) stated that “the authorities’

rules-based fiscal framework over the medium term clearly establishes their commitment

to further debt reduction.” The basic thrust of this analysis was reaffirmed in the 2010 and

2011 FCL renewals.

(vi) Low and stable inflation, in the context of a sound monetary and exchange rate policy

framework: Regarding inflation and the monetary and exchange rate policy framework,

IMF evaluation reports concluded that the FCL3 countries have gained credibility through

their inflation-targeting frameworks and a flexible exchange rate policy. Inflation expecta-

tions are regarded as being firmly anchored at relatively low levels, and the depreciation

of the respective currencies during the 2007–2008 crisis did not lead to substantial infla-

tion. The basic thrust of this analysis was reaffirmed in the 2010 and 2011 FCL renewals.

(vii) Absence of systemic bank solvency problems that might constitute the imminent threat

of a systemic banking crisis: With respect to systemic bank solvency problems, the IMF

concluded that the FCL3 countries all had well-capitalised banking systems which had

undergone stress tests showing that they were able to cope with severe shocks to the sys-

tem. Bank profitability was deemed good, with banks showing adequate liquidity. The

same diagnosis was delivered in the 2010 and 2011 renewals of the FCL.

(viii) Effective financial sector supervision: Regarding financial sector supervision, the

IMF considered all FCL3 countries to have strong and effective supervisory and regula-

tory frameworks in their financial sector. The IMF felt that the FCL3 could intervene

promptly with the banks if needed and that they had made substantial progress in imple-

menting the recommendations contained in their respective FSAPs. The IMF noted that

the FCL3 had improved their coordination of different supervisory bodies as a result of the

2008 financial crisis.

(iv) Data transparency and integrity: The IMF pointed out that all FCL3 countries have

good data quality, that they have been subscribers to the Special Data Dissemination Stan-

dard (SDDS) for many years, and that the Fund’s Reports on Observance of Standards and

Codes (ROSC) were very positive in terms of the evaluation of periodicity and timeliness

requirements. The same diagnosis was delivered in the 2010 and 2011 FCL staff report

assessments.

4 The Council of the European Union’s (2011, 6) assessment of the Polish fiscal situation was more criti-

cal: “Poland has strengthened its fiscal framework over the years. However, in order to assure sustain-

ability of public finances in the medium to long term the existing fiscal rules and medium-term pro-

gramming procedures do not appear to provide for sufficient transparency of the budgetary process, in-

centives for coordination between various tiers of government and flexibility to address macroeconomic

shocks and imbalances. The fiscal rules should also be based on sufficiently broad budgetary aggre-

gates and should be consistent with the European System of National and Regional Accounts (ESA 95).

According to the Commission’s latest assessment, the risks with regard to long-term sustainability of

public finances appear to be medium.”



Table 2: Key economic figures for Colombia, Macedonia, Mexico and Poland

2007 2008 2009 2010 2011

Colombia GDP per capita, USD current prices

Inflation, average consumer prices, % change

General government revenue, % of GDP

General government total expenditure, % of GDP

General government fiscal position, % of GDP

General government net debt, % of GDP

Current account balance, % of GDP

External debt stocks

(% of exports of goods, services and income)

External debt stocks (% of GNI)

Total reserves (% of total external debt)

Total reserves in months of imports

4,794

5.54

27.18

28.21

-1.03

22.96

-2.86

121.15

21.91

47.95

5.32

5,303

7.00

26.33

26.29

0.04

20.96

-2.94

104.53

19.81

50.98

5.00

5,207

4.20

26.52

29.05

-2.53

26.93

-2.20

131.89

23.03

47.94

6.08

6,360

2.27

24.37

27.47

-3.10

28.09

-3.09

135.35

22.84

44.52

5.61

6,980

3.25

25.26

28.27

-3.02

29.18

-2.62

Macedonia GDP per capita, USD current prices












3,998

2.26

32.21

31.62

0.59

20.19

-6.95

94.07

53.52

54.42

4.24

4,828

8.36

32.48

33.41

-0.93

18.58

-12.83

88.87

48.16

45.08

3.18

4,550

-0.81

30.52

33.17

-2.65

21.08

-6.70

150.09

60.83

40.91

4.63

4,483

1.51

30.07

32.54

-2.47

23.08

-2.75

131.84

65.07

39.23

4.22

5,012

4.40

30.86

33.37

-2.51

23.84

-5.54

Mexico GDP per capita, USD current prices












9,786

3.97

21.29

22.46

-1.18

31.13

-0.86

60.12

17.56

48.83

3.15

10,255

5.13

22.98

24.09

-1.11

35.58

-1.49

59.04

17.34

50.93

3.19

8,174

5.30

22.35

27.03

-4.69

39.07

-0.72

68.67

19.76

58.25

4.32

9,522

4.15

21.98

26.28

-4.31

39.31

-0.54

62.68

19.52

60.27

4.18

10,803

3.37

21.58

24.82

-3.24

39.34

-0.95

Poland GDP per capita, USD current prices








11,157

2.49

40.31

42.19

-1.88

10.22

-6.23

3.67

13,887

4.22

39.52

43.19

-3.68

9.94

6.60

2.83

11,296

3.45

37.16

44.51

-7.35

15.04

-3.99

4.84

12,323

2.58

37.85

45.70

-7.86

21.35

-4.47

4.85

13,967

4.03

40.25

45.79

-5.54

24.52

-4.81

Sources: Compiled with data from IMF WEO September 2011 and World data Bank January 2012



Impact of FCL on FCL3 countries

Conditions on financial markets improved for all FCL3 countries after the announcement

of the respective FCL arrangement. In general, the exchange rate appreciated, private and

sovereign risk spreads (measured by Emerging Markets Bond Index (EMBIG) and Corpo-

rate Emerging Markets Bond Index (CEMBI) spreads, respectively) narrowed, and the

stock market posted a strong recovery (cf. Figures 1–3).

Indeed, in its respective reviews, the IMF highlighted the positive impact of the FCL on

all three economies. In the case of Mexico, the IMF (IMF 2009j; 3) stated that “[a]round

the announcement of the intent to seek support under the FCL, Mexican CDS spreads and

the exchange rate staged a strong recovery [...] while risk relativities versus other emerg-

ing market peers also improved”. In the case of Poland, the IMF (2009k, 17) reported that

“Poland is benefiting from the FCL arrangement. The strengthening of the zloty, reduc-

tion in sovereign external spreads, increasing capital inflows, and declining yield on gov-

ernment bonds have in part reflected the stabilizing impact of Poland’s FCL agreement”.

In the case of Colombia, the IMF commented that “[e]quity prices in the region have re-

bounded – in some countries by over 40 percent – with Colombia’s stock market index

returning to pre-Lehman levels by end-June. EMBI spreads for Latin American countries

fell by about 135 basis points (160 basis points for Colombia) from April to September”

(IMF 2009, 3). Overall, the IMF evaluation of the FCL seems very positive in terms of the

latter’s stabilising effect on markets in the FCL3 countries.

The positive effects, however, should not be overemphasised or attributed solely to the

FCL. As can be seen in Figures 1–3, most indicators had already started to improve before

the announcement of the arrangement. In Columbia, for instance, the interest on govern-

ment bonds dropped slightly after the first FCL announcement, but this was the continua-

tion of a decline in interest rates that had started in the third quarter of 2008. Moreover,

yields on Columbian government bonds started to rise again less than two weeks after the

announcement.5

Critics of the FCL argue that the improvement in financial market conditions for the FCL3

countries was part of an overall improvement and that it would be a mistake to attribute

the improvement in financial conditions of the FCL3 to the FCL arrangements. For in-

stance, Fernández-Arias / Levy-Yeyati (2010) argue that the improvement in financial

conditions after the April 2009 London Summit was a generalised phenomenon in which

the FCL3 countries benefited from a rising tide that lifted all boats. They compare a con-

trol group with the FCL3 countries’ performance and find no significant difference be-

5 Moody’s announced a possible upgrade of Colombia’s foreign currency bonds on 9 September 2010 and

an actual upgrade from Ba1 to Baa3 on 31 May 2011. This was followed by Standard and Poor’s up-

grade of Colombia’s long term foreign currency bonds to “BBB-” from “BB+” on 31 May 2011 and an

upgrade by Fitch Ratings of the sovereign foreign currency credit rating for Colombia by one notch to

BBB-minus on 21 June 2011. While these upgrades were not linked by the rating agencies to Colom-

bia’s FCL arrangement (which was indeed much earlier, on 11 May 2009), the rating agencies con-

firmed the IMF’s positive outlook for Colombia. The ratings of Mexico and Poland have not changed

since these countries entered into their respective FCL arrangements.



tween the two groups in terms of the improvement of financial conditions. Fernández-

Arias and Levy-Yeyati hence conclude:

“[i]t is nevertheless tempting to attribute the tightening of EM spreads after the Lon-

don G20 summit in April 2009 to the creation of a new approach in the form of the

IMF FCL or the momentum created by the bilateral swaps with the US Fed and the

expectation of their widespread application. In this way of thinking, the new facilities

offered widespread potential protection and were behind the favorable undercurrent,

having therefore a substantial effect beyond the particular countries to which they

were applied. However, the new facilities appear too selective to account for the wide-

spread improvement across the country spectrum. In fact, a more rigorous examina-

tion of this optimistic interpretation of the evidence also casts serious doubts about it

and suggests that the widespread improvement of risk spreads after the London sum-

mit cannot be attributed to the availability of these new liquidity facilities.”

Fernández-Arias and Levy-Yeyati certainly have a point in saying that it is difficult to

attribute an improvement in the FCL3’s financial conditions to just one factor such as the

FCL at a time when the world was undertaking a large number of measures to recover

from the severe crisis of 2008. It is important to remember the unprecedented set of meas-

ures implemented to recover from the recession and prevent crises like this one from re-

peating themselves in future. The G20 Leaders’ Statement of the London Summit in April

2009 highlights the actions taken (cf. G20 2009b). These included boosting the public

international resources of international financial institutions and trade finance by USD 1.1

trillion in order to support credit, growth and jobs. Moreover, G20 countries embarked on

unprecedented and concerted fiscal expansion; interest rates were cut to near-zero levels,

unconventional instruments to provide monetary stimulus were utilised and significant and

comprehensive support was given to banking systems in order to restore the normal flow

of credit. When evaluating the FCL’s impact one thus has to be aware of several other

forces which were also at work at the time.

Furthermore, it should also be remembered that the FCL is a crisis prevention instrument

for countries with very strong fundamentals. The FCL should not be expected to lead to an

overnight improvement of a country’s credit rating, its sovereign bond spreads, its ex-

change rate, or its domestic bond rates. An FCL country should be in a good position re-

garding all these indicators to begin with. Like an individual who buys health insurance,

one is expected to be in good health at the time of the purchase.6 The coverage is intended

to help cope with an unexpected situation or event. Health insurance per se will not lead to

improved health. To look for correlations between the FCL and financial market indica-

tors, in a sense, misses the point of the FCL. Indeed, the purpose of the FCL, among other

things, is to lower the probability that a country will face a financial crisis; this in turn

should have a positive effect on financial variables. However, the magnitude and timing of

the effect seem to be very difficult to estimate given all the other variables that impinge on

6 The Polish Finance Minister Jacek Rostowski likened the FCL to “installing good locks on the doors”

to increase security and stated that Poland would activate the FCL only “if we had a serious attack on

the zloty or a sharp depreciation of the currency. But these problems are less likely because everybody

on the market knows that we have this access.” (Rastello 2010)



this probability.7 Indeed, as we are well aware, estimating this probability is the job of

credit rating agencies (which for their part have come under heavy criticism for misjudg-

ing sovereign risks in many cases, not least in the case of Greece).

Moreover, the available FCL evidence indicates that the three pioneer countries apparently

value the FCL highly, since all of them have renewed the instrument on two occasions.

This fact is a signal that the FCL is considered useful by countries which want to benefit

from the FCL’s function as insurance. Moreover, it signals that there has been no stigma

problem and that markets have regarded the process favourably. Market analyst reports

indicate that the FCL has been correctly understood as an instrument that boosts a coun-

try’s contingent liquidity. For instance, after Mexico requested its first FCL arrangement,

Oxford Analytica (2009) published a report titled “IMF aid boosts Mexico’s credibility”.8

On the renewal of Mexico’s FCL arrangement in January 2011, Bloomberg quoted a cur-

rency trader to the effect that “[t]his is a cheap way of accumulating reserves and it’s

good for the peso [...]. It’s a vote of confidence and it tells you that Mexico has solid fun-

damentals” (Martinez 2011).

7 Market analysts seem to share this view. A day after Mexico requested a renewal and increase of its

FCL in December 2010, Bloomberg cited from a JPMorgan Chase & Co. note to clients: “This, in our

view, is a clear signal of Mexico’s strong fundamentals [...]. However, we believe this is not a short-

term market mover, as this is something that Mexico somehow had before.” (Martinez 2010)

8 In this report, Oxford Analytica (2009) described the FCL request as “mutually beneficial for Mexico

and the IMF” since Mexico would “significantly boost its standing as a country with a solid policy re-

cord and prospects”, while the IMF would benefit from “Mexico break[ing] the stigma attached to

countries requesting resources from the IMF, which has pushed countries in relative good economic

health to seek to avoid the institution, borrowing massively from the World Bank and regional develop-

ment banks.”

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24 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)

4.2 Experience with the PCL

The PCL found only one user: on 19 January 2011, the IMF approved a two-year ar-

rangement of Special Drawing Rights (SDR) 413.4 million for Macedonia for cumulative

access to 600 percent of quota. Macedonia requested the PCL to help protect its economy

against external risks in view of the financial volatility prevalent in the region. The IMF

stated that “having a PCL in place would send a positive signal that policies are sound

and that the authorities have adequate resources to draw if needed, which should

strengthen investor confidence and improve access to international capital markets” (IMF

2011g, 5). The immediate market response was moderately positive (Figure 4), but like in

the above-discussed cases of the FCL, the PCL announcement for Macedonia itself should

not be seen as a major game changer regarding financial market’s assessment of the Ma-

cedonian economy.

Upon approval of the arrangement, Naoyuki Shinohara, Deputy Managing Director and

Acting Chair, stated: “Despite the broadly favorable outlook for growth and macroeco-

nomic stability, vulnerabilities to spillovers from economic and financial volatility in the

region remain. The PCL will mitigate the risk of contagion, including by signaling sound

policies. In light of Macedonia’s strong fundamentals, the absence of balance of payments

pressures at present, and the generally positive economic prospects, Macedonia is not

expected to draw upon the resources available under the PCL. Nevertheless, the availabil-

ity of these resources, if needed, will provide important insurance against the possibility of

adverse external developments.” (IMF 2011g)

However, the expectation that Macedonia would not draw upon its PCL arrangement with

the Fund were only short-lived. Contrary to the FCL3 countries, which have not drawn a

single SDR from their respective arrangements, Macedonia utilised the PCL resources

only two months after the arrangement was in place: on 23 March 2011, the IMF reported

that Macedonia had drawn EUR 220 million out of the EUR 390 million available to it

under the PCL.9 The reason given by the Macedonian authorities for drawing upon the

PCL was “the changed circumstances brought about by the early elections, including a

delay in the planned Eurobond issuance” (IMF 2011h).

This action by Macedonia raised doubts about the precautionary nature of the PCL ar-

rangement, particularly given the fact that the withdrawal was made only two months after

the IMF had certified the qualification criteria for Macedonia, including access to external

market financing. Some commentators were severely critical of the drawing, arguing that

it was motivated by the government’s need to “plug gaping budget holes, the outcomes of

its populist spending spree on the eve of early parliamentary elections” (Vaknin 2011).

Nonetheless, in its first review of Macedonia’s performance under a PCL arrangement in

September 2011 the IMF reaffirmed Macedonia’s continued qualifications for accessing

PCL resources and emphasised that Macedonia continued “to pursue sound economic

9 Under the current PCL arrangement, Macedonia has access to SDR 344.5 million (500 percent of quota)

in the first year, rising in the second year to a cumulative SDR 413.4 million.


German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 25

policies that are consistent with the program supported by the [PCL] arrangement” (IMF

2011j). According to the Fund, Macedonia’s decision to draw on the PCL arrangement

“highlighted remaining external vulnerabilities” and a need for “strengthening debt man-

agement policies and practices”, in particular a necessity for “improving access to exter-

nal funding and [...] developing the domestic public debt market” (IMF 2011j), issues the

Macedonian government was now addressing with the support of IMF technical assis-

tance.10

After just one year it is still too early to fully evaluate experiences with the PCL, espe-

cially since only one country has used it. However, what is clear is that, as with the FCL,

countries are not lining up to request a PCL arrangement or a PLL, its replacement, even

though the PCL/PLL would seem to be of value for countries whose fundamentals are in

an intermediate range.

5. Problems and concerns with the Fund’s precautionary facilities

5.1 Why are more countries not taking advantage of the Fund’s precautionary

facilities?

The experience gained with the FCL3 would make it appear that the FCL has been a very

successful instrument. The FCL has had a truly precautionary effect, as corroborated by

the fact that not a single SDR has been used under the FCL notwithstanding the very vola-

tile world economic and financial situation during the 2009-2011 period. The countries

using the FCL seem to be satisfied with the instrument, since all three of them have re-

newed the FCL two times and have taken advantage of the larger amounts available and

the longer duration. Indeed, the FCL3 country authorities stated that the FCL has been

instrumental in diminishing their need to accumulate larger amounts of precautionary re-

serves. Market analysts have regarded the use of the FCL by all three countries as positive

and have recognised it as an important complement to the countries’ own reserves. Ana-

lysts have understood that the FCL is granted only to countries with an excellent track

record of policy implementation, and this fact has accordingly helped to improve assess-

ments of the respective country’s creditworthiness. Of course, none of the FCL3 have suf-

fered a balance of payments problem or a financial crisis. The experience with the now

abandoned PCL is still very recent, and the case of Macedonia is open to different inter-

pretations.

In spite of success with the FCL, only a few countries have made use of this crisis preven-

tion instrument that took the IMF so long to develop and was recently enhanced by the

IMF in terms of available amounts and lifetime periods. One possible explanation is that

10 On 24 August 2011, Standard and Poor’s lowered Macedonia’s long-term local currency sovereign

credit rating to “BB” from “BB+”. While the downgrade was due to a revision of Standard and Poor’s

methodology and assumptions for rating sovereign governments, the agency also highlighted “structural

rigidities, inflexible government expenditure structure, and residual latent (albeit declining) risk of in-

ter-ethnic tensions”.



countries which might potentially qualify have acquired “sufficient insurance” through the

accumulation of reserves and because, in effect, there is no further demand at this time for

the instrument. Indeed, the members show a strong preference for building up their own

reserves in order to avoid having to turn to the IMF (IMF 2010c). Another plausible ex-

planation is that the mere existence of the Fund’s precautionary arrangements and the

rapid process of accessing them provide sufficient insurance as long as market participants

feel that a country meets the respective qualification requirements. In this scenario, poten-

tially eligible countries benefit without the need of going through the formal qualification

process. Another possibility is that potentially eligible countries believe that the risk of

contagion or a rapid, unpredictable turnaround in market confidence for their countries has

diminished considerably, and hence they do not require a crisis prevention instrument.

In the following we discuss three further, major problems associated with the FCL and

PCL/PLL from the perspective of a member country which might be interested in these

facilities: (i) the stigma problem; (ii) the entry and the exit problem; and (iii) the cost of

insurance.

The stigma problem

The IMF (2010c) conducted a survey (prior to the most recent enhancements of the FCL)

to try to fathom the reasons behind the relatively scarce demand for the FCL. In the stake-

holders’ responses, the issue of stigma attached to Fund lending is still strongly present as

a leading argument against the use of the FCL. This “stigma” means the political stigma of

having recourse to the IMF. The IMF (2009i, 12) itself is aware of the stigma problem and

acknowledges that “[i]t is no secret that members resist approaching the Fund for financ-

ing due to the political stigma of such borrowing, and in the process may allow their prob-

lems to fester. Additional evidence of such stigma is provided by the existence of a clear

demand for ‘Fund-type’ financial support by other international financial institutions and

central banks.”

Examples of alternative sources of crisis finance include the provision of balance of pay-

ments assistance via Development Policy Loan (DPL) by the World Bank, similar contin-

gency lending by regional development banks and an unprecedented rise of swap agree-

ments between central banks of major economies and their counterparts in smaller coun-

tries.11 For instance, when Indonesia, despite the country’s relatively strong economic po-

sition, experienced refinancing problems after the outbreak of the global financial crisis,

the government did not consider IMF support an option because of the negative reputation

the Fund still has in the Indonesian society as a legacy of its role during the Asian crisis.

Instead of going to the Fund, the Indonesian government turned to the World Bank and

secured a USD 2 billion DPL with a deferred drawdown option (DDO) in March 2009 (cf.

World Bank 2011) – a form of contingent financing somewhat similar to the IMF’s new

11 For the World Bank’s crisis response see World Bank (2010). For an analysis of central bank swap ar-

rangements during the crisis see Aizenman et al. (2010).



crisis prevention facilities.12 The World Bank’s DPL DDO was the largest component in a

USD 5.5 billion contingent financing facility to which also the governments of Australia

and Japan and the Asian Development Bank contributed. Even though the DPL DDO was

never disbursed, its approval sent a strong positive signal to international and domestic

markets and boosted market confidence so that Indonesia was able to raise more than USD

6.3 billion through five bond issuances in the capital markets between September 2008

and March 2009.

In order to promote a more intense use of its precautionary facilities by countries that face

financial contagion problems, the Fund needs to address the factors that are hindering de-

mand. First, it must improve its outreach activities in order to diminish the political stigma

of IMF involvement. In a large number of developing and emerging economies, not least

in Latin America and East Asia that went through Fund programmes in the 1980s and

1990s, the Fund’s reputation is still very poor and Fund policies are seen as following the

interests of the largest shareholders (that of the US government in particular).13 As

Fernández-Arias and Levy-Yeyati (2010) point out, “[n]ow that fears of being punished

by the market have been put to rest [after the experience of the FCL3], it became clear

that, if there is a stigma associated with IMF involvement, its roots are political rather

than economic.” The IMF needs to address these concerns head on. In particular, the IMF

ought to continue the governance reform process in order to address the widespread con-

cern that its policies are dominated by the large shareholders; it should also increase the

sense of ownership on the part of the smaller member countries. The large member coun-

tries also need to deliver on their promise of an open and transparent selection process for

the position of managing director when the position becomes vacant again.

The long-standing perception that countries have recourse to the IMF only in a crisis situa-

tion is also not conducive to strengthening the crisis prevention toolkit of the IMF (The

Economist 2009; Goldstein 2009). However, the existence of a well-functioning crisis

prevention instrument is fundamental if the IMF is to permanently occupy its intended

position as the central institution of the international monetary system. Otherwise, the IMF

will go through cycles of relevance and irrelevance, depending on whether a crisis is pre-

sent in the world economy. The examples of the FCL3 countries should be used to point

out the benefits attached to crisis prevention actions and to highlight the positive nature of

the relationship between the IMF and the member countries in this arena. This is a chal-

lenge for the communication strategy of the IMF and requires the full support of the Ex-

ecutive Board. In particular, the Executive Board, the management and the IMF staff need

12 The DPL DDO is a contingent credit line for IBRD-eligible borrowers that have met the World Bank’s

pre-approval criteria, which include an appropriate macroeconomic policy framework and satisfactory

programme implementation. Under a DPL DDO, the borrowing country can defer disbursement for up

to three years, renewable for an additional three years. The DPL DDO can be activated at any time dur-

ing the three year drawdown period unless the World Bank has notified the borrower that one of the

drawdown conditions is not being met any more. For further information on the DPL DDO see World

Bank (2012).

13 It is hence not surprising to hear allegations that only countries whose governments are seen as rela-

tively cozy with the US – namely Mexico, Colombia and Poland – have requested an FCL.



to embrace the FCL, to recognise its success, and to support actions that will provide the

IMF with the contingent resources needed for this instrument.

The entry and exit problem

The entry – or first mover – problem describes a situation in which a country seeking in-

surance via a precautionary facility may be suspected by the markets of having hidden

vulnerabilities. After all, why should a country with “very strong economic fundamentals

and institutional policy frameworks” (in the case of the FCL) seek extra insurance through

the IMF? The fear is that seeking IMF insurance could be interpreted as a sign of weak-

ness and hence cause the opposite of what it aims to do, namely to boost market confi-

dence in the economy in question. As discussed, the experiences of the FCL3 give no rea-

son to assume that a country seeking an FCL would encounter an entry problem. The case

may be different with the PCL, given that it was intended for member countries whose

fundamentals are in an “intermediate range” and hence do not meet the criteria for an

FCL. Moreover, the recent experience with Macedonia may have set a negative precedent

for the PCL: after all the Macedonian government drew on its PCL arrangement with the

Fund only two months after the IMF had certified that Macedonia met all PCL qualifica-

tion criteria, including that of access to external market financing. This raised doubts

about the precautionary nature of the PCL arrangement and might have deterred other

countries from seeking a PCL.

The exit problem, on the other hand, describes a situation in which non-prolongation

(“graduation”) of a precautionary arrangement may unsettle markets if it is perceived that

the country in question no longer qualifies and that the arrangement was therefore termi-

nated by the Fund. The termination of insurance could cause market uncertainties and

worsen the countries’ financing conditions if the exit from the precautionary arrangement

is not properly communicated and accompanied by credible economic fundamentals.

However, since the qualification requirements under the various precautionary arrange-

ments are clearly spelled out, markets can verify whether a country continues to qualify or

not. This should reduce the concerns countries may have that they would be forced to

cling to such an arrangement once they have entered it. To boost market confidence upon

graduation, it may be useful for the IMF to carry out a final graduation assessment in

which the IMF checks whether the exiting country would fulfil the criteria for prolonga-

tion of the arrangement. If this is the case, the exiting country could be given an option to

enter into a new follow-up arrangement within a six-month period after graduation with an

expedited qualification assessment.

Cost of insurance

A further point that may affect a country’s decision to apply or not apply for a precaution-

ary arrangement is the cost of insurance. While the cost of drawing on a precautionary

arrangement is the same as under an SBA, countries that seek an FCL/PCL/PLL arrange-

ment with the Fund also need to pay a commitment fee that increases with the level of

access available (it is refunded if they opt to draw on it). The average commitment fee



levied on a 500 / 1000 / 1500 percent of quota arrangement is 24 / 27 / 40 basis points

(IMF 2011k; IMF 2011l). For instance, Mexico’s annual payment for its USD 72 billion

FCL amounts to USD 286 million (SDR 180 million). While this is a significant cost, it

pales when compared with the costs of holding foreign currency reserves (which in the

current environment has a negative carry for many countries). The cost of insurance also

has to be seen in relation to the benefits of having this insurance, even if these are hard to

quantify.

As with other non-concessional IMF facilities, the actual borrowing cost under the

FCL/PCL/PLL varies with the scale and duration of lending, with the lending rate being

tied to the IMF’s market-related interest rate (or basic rate of charge). The effective inter-

est rate under the FCL/PCL/PLL (like that of the SBA) for access between 500 and 1000

percent of quota is currently between 2.2 and 2.8 percent, rising to about 2.6 to 3.5 percent

after 3 years, and higher for access above 1,000 percent of quota as a means of discourag-

ing large and prolonged drawing. In addition, the borrowing country also has to pay the

flat 50 bps service charge required for all Fund disbursements.

For Macedonia, the costs of drawing EUR 220 million from its PCL arrangement in

March 2011 were below what it would have paid under commercial borrowing conditions

if the costs of its recent commercial borrowing are taken as a reference.14

We conclude that there are several forces at work which inhibit more generalised use of

the IMF’s precautionary facilities. On the demand side, the predominant factors are politi-

cal stigma attached to the use of Fund resources, a situation characterised by abundant

reserves held by the main emerging market countries, the recent experience of ample swap

lines arranged between central banks, uncertainty regarding whether a country qualifies

for the FCL, and possibly also a fear of not qualifying. On the supply side, the IMF does

not seem to be actively promoting the instrument. The current critical situation in some

countries in which the IMF is intensively involved certainly implies that it has other pri-

orities. Moreover, the IMF may be concerned about the sufficiency of Fund resources for

its traditional lending activities. It is clear that under current rules, the FCL absorbs a huge

amount of the Fund’s liquidity due to the size of the resources committed, a problem also

discussed below.

5.2 Further problems with the Fund’s precautionary facilities

Besides these issues affecting the demand for the Fund’s precautionary facilities, there are

also problems on the lending side. These are (i) the moral hazard associated with ex ante

conditionality; (ii) the “freezing” problem; and (iii) concerns that unconditional liquidity

provision by the Fund would create inflationary pressures and require central banks to

provide ample liquidity through the SDR mechanism.

14 According to Vaknin (2011), Macedonia paid 4.2 percent on its last tranche of short-term Eurobonds

and 9.8 percent on its 3-year Eurobond issued in 2009.



The moral hazard of ex ante conditionality

As mentioned earlier, the moral hazard problem associated with ex ante conditionality has

been a long-standing concern of economists inside and outside the Fund and has been the

subject of much debate within the Executive Board ever since discussions about creating

precautionary facilities started. Regarding concerns by IMF creditor countries, there has

been no hint of moral hazard considerations in terms of looser policies implemented by the

FCL3 because of IMF insurance. Moreover, the IMF has benefited because the effective-

ness of its surveillance of these economies has improved. The pilot cases have been work-

ing precisely as intended in the design of the FCL. This means that the IMF should be able

to promote its insurance policy to its member countries more effectively. For the world

economy, a reduction in the probability of countries facing a crisis means a better envi-

ronment. With the FCL, the IMF has been able to commit a level of access to its resources

which is much higher and more in line with current capital flow volatilities or contagion

risks, and has enhanced the incentives for countries to adopt strong policies before capital

account pressures emerge. These actions have helped to boost market confidence and re-

duce the probability of a crisis. In financial terms, the IMF has benefited because it has

committed a large amount of its resources which on the other hand have not been with-

drawn, which implies income in the form of the commitment fees charged for FCL re-

sources.

In the case of the PCL, as mentioned above, there have been allegations of moral hazard,

inasmuch as Macedonia was accused of having abused its PCL. However, the IMF did not

consider the withdrawal to be out of line with the guidelines of the PCL, and on 23 June

2011 the IMF (2011i) stated that “[o]n the basis of the authorities’ record in the first part

of this year and their continued commitment to achieving the goals of their economic pro-

gram for the remainder of 2011, the mission will recommend completion of the first PCL

review to IMF management.” Nonetheless, some analysts will assuredly see their moral

hazard concerns as confirmed by the Macedonian case.

The freezing problem

In the context of problems with several crisis countries that require significant amounts of

Fund financing, it is important to analyse ways of leveraging Fund resources. In the par-

ticular case of the FCL and PCL/PLL, the current practice is to freeze the total amount of

resources committed under the FCL and PCL/PLL, i.e., the Fund must put aside 100 per-

cent of the resources committed under the FCL/PCL/PLL. As of 17 November 2011, the

FCL accounted for 43 per cent of the total amounts committed by the IMF under current

financial arrangements in the general resources account (Table 3). This huge share has led

to concerns that greater use of the FCL by relatively large countries could tie up an enor-

mous amount of IMF resources. Consequently, the use of resources for precautionary pur-

poses could lead to a crowding out of resources for crisis resolution purposes.

However, it should be recognised that contingent financing under the FCL could be

funded with contingent sources of funds for the IMF. It seems excessive to reserve 100 per

cent financial backing for a facility in which not a single SDR has been withdrawn under



these programmes during a three-year period of great volatility in the world economy.

Indeed, as pointed out by Lipsky (2010) “[t]he Fund’s membership made the application

of such contingent facilities [FCL] credible by agreeing to provide substantial amounts of

contingent funding through the expanded New Arrangement to Borrow (NAB).”

Another potential instrument that the IMF could make use of as a contingent funding

source is the SDR mechanism. Indeed, the SDR could be used for backing up the contin-

gent financing provided by the IMF. In reviewing the role and function of the SDR, it has

been argued that SDRs could be issued on a transitory basis or on-lent to countries in sup-

port of strong policy programmes in the context of a liquidity crisis. Truman (2010b; 15),

for instance, suggests that the IMF amend its Articles of Agreement to “allow the IMF to

approve a special, temporary allocation of SDR in a crisis, perhaps subject to endorse-

ment by the International Monetary and Financial Committee (IMFC) and prior to action

by the Executive Board, without requiring an 85 per cent weighted majority vote of IMF

governors […]. The subsequent cancellation of the SDR over a five-year period would

follow a declaration of the end of the crisis and might require only a majority vote”. Tru-

man also suggests the activation of Fund borrowing in international capital markets. The

sole availability of this mechanism would give confidence to markets that the IMF is thor-

oughly equipped to face crisis situations.

Furthermore, the Fund should explore the establishment of links between usage of its pre-

cautionary facilities and available contingent financing from regional financing arrange-

ments (RFAs). By linking IMF resources to resources from RFAs, not only could the size

of a precautionary arrangement be increased, a collaboration between RFAs and the Fund

in providing a joint precautionary arrangement could also boost the acceptance of such a

programme, since it would increase the sense of regional ownership.

Concerns over inflationary pressures from unconditional liquidity provision by the Fund

Lastly, a concern with unconditional liquidity support from the Fund is often raised by the

central banking community. The fear is that the Fund might create excessive unconditional

liquidity which would require de facto central bank participation to ensure the liquidity of

the SDR system. In particular, there is worry that the creation and issuance of additional

SDRs might flout the monetary independence of the central banks which issue the main

Table 3: Current financial arrangements (GRA) as of 17 November 2011

Amount agreed

(bn SDRs)

Outstanding

(bn SDRs)

Amount agreed / total

amounts (%)

Extended Arrangements 43,546 17,326 26.40

Stand-by Arrangements 50,653 42,554 30.71

FCL 70,328 0 42.64

PCL 413 197 0.25

Total 164,941 57,502 100.00

Source: Compiled by authors with data from IMF (2011c).



reserve currencies and force them to enlarge their balance sheet by requiring them to buy

SDRs from countries with liquidity needs in exchange for their own currencies.15

However, as Cooper (2011) points out, “[t]he allocation [of SDRs] per se has no mone-

tary effect, simply providing participants’ monetary authorities (usually ministries of fi-

nance or central banks depending on the domestic arrangements) with an additional con-

tingent claim on SDR Department participants – contingent, since use of SDRs under the

designation mechanism requires a balance of payments or reserve position need (Article

XIX.3).” Even if SDR holdings are exchanged for freely usable currency, which would in

most cases mean dollars or euros, this would not always imply an increase in money sup-

ply, but often only a transfer of foreign exchange from one country to another without

monetary effect (Cooper 2011). Even though the issuers of freely usable currencies cre-

ated money in exchange for SDRs, they could sterilise money creation if it exceeds the

desired level. The inflationary impact should hence be limited even in the case of large

cumulative SDR allocations. The discretion to cancel existing SDR allocations at times of

strong global demand and inflation concerns is an additional safeguard (IMF 2011m).

6. Conclusions and recommendations

Economic and financial crises carry enormous costs in terms of output loss and employ-

ment, as evidenced by the recent systemic crisis. Therefore, a fundamental aspect of inter-

national monetary cooperation is to step up efforts directed at crisis prevention. For many

years, the IMF has been aware of the value of crisis prevention and has tried to improve its

surveillance over countries’ economic policies to this end. Unfortunately, the historical

record shows that surveillance has not been very effective in deterring the build-up of

large imbalances. The recent crises prompted important improvements in the surveillance

process by strengthening surveillance, particularly in the financial sector, through the

FSAP, the GFSR, and the EWEs, which are valuable instruments for timely identification

of trends and policies that may lead to a crisis down the road. Additionally, the G20 MAP

is being developed with the aim of identifying the spillover effects of countries’ domestic

policies. It should be instrumental in exerting greater peer pressure for the detection and

correction of imbalances at their initial stages as a means of preventing imbalances from

evolving into major disequilibrium in the world economy.

Surveillance, if effective, is the ideal crisis prevention tool. However, the lessons of ex-

perience suggest that its effectiveness depends on the will of the largest economies to de-

termine their domestic policies by taking into account their impact on the rest of the world.

This is an evolutionary process that has to be supplemented with other tools of crisis pre-

vention. In this context, and considering that the world economy will never be exempt

from crisis, the fortification of the IMF’s crisis prevention toolkit through creation of the

FCL and PCL represents an important boost to the architecture of the international mone-

15 This view was recently expressed, for instance by Weber (2011): “substantial new SDR allocations and

the use of SDRs [...] would influence global liquidity conditions and even interfere with the monetary

policy of those central banks that issue the major reserve currencies.”



tary system. The initial experience with the FCL has been very positive. It has been used

as a truly precautionary facility. Not a single SDR has been withdrawn by the three pio-

neer FCL countries, notwithstanding the volatile world economic and financial environ-

ment of 2009-2011. The FCL has been a valuable supplement to their reserves and has

provided a valued insurance policy against tail risks, as corroborated by the renewal of the

FCL on two consecutive occasions. Moreover, the FCL has created the right incentives for

countries to maintain strong macroeconomic policies.

The experience of the FCL pioneer countries shows that moral hazard concerns in terms of

looser policies which might arise because a country carries IMF insurance have not mate-

rialised. Accordingly, it is fair to say that the FCL has improved the effectiveness of IMF

surveillance over these economies. This is beneficial for the world economy, since a re-

duction in the probability of a country facing a crisis means a less volatile environment.

With the FCL, the IMF has been able to commit a much higher level of access to its re-

sources to crisis prevention in a way which is more in line with current capital flow vola-

tilities and contagion risks. This has boosted market confidence and reduced the probabil-

ity of a crisis. The IMF’s own financial position has benefited from the commitment fees

charged to FCL resources.

The experiences with the PCL are still inadequate for drawing conclusions, especially

since only one country has signed up for it. The Macedonian example, however, is not

very encouraging, given that it drew on the PCL just two months after passing the qualifi-

cation criteria. It remains to be seen whether the PLL, which has replaced the PCL, will

attract more interest.

The challenge for the international financial community and the IMF is to promote the use

of precautionary facilities by countries facing contagious pressures, to build firewalls early

on when such pressures arise to effectively prevent financial contagion. The first step is

for the IMF to improve its outreach activities in order to diminish the political stigma of

IMF involvement. It must transmit the message that usage of its precautionary facilities

does not mean that a country is in a crisis situation or that it has hidden vulnerabilities. A

better differentiation between the IMF’s crisis prevention instruments and traditional

emergency financing or “crisis resolution” instruments is required. The existence of a

well-functioning crisis prevention instrument is fundamental for the IMF’s permanent po-

sition at the centre of the international monetary system. The promotion of crisis preven-

tion instruments such as the FCL and PLL requires the full support of the Executive

Board. In particular, the Executive Board, along with the IMF’s management and staff,

need to embrace the FCL and PLL and to support actions that will provide the IMF with

the contingent resources needed for ensuring the credibility of these instruments. Other-

wise the IMF will go through cycles of relevance and irrelevance depending on whether a

crisis is present in the world economy.

Furthermore, the Fund should explore and promote the establishment of links between use

of the FCL/PLL and available contingent financing from RFAs. Given the Fund’s stigma

problem, RFAs have become an attractive alternative to IMF lending (McKay et al. 2011).

While RFAs can be constructive in preventing or combating financial crises, and a healthy



competition for surveillance and ideas between RFAs and the IMF should be welcome,

dangers for (global) financial stability may arise when an RFA undermines the Fund’s

authority and complicates the Fund’s work instead of complementing it. Hence, ways are

needed to ensure an efficient interaction between RFAs and the Fund. The FCL and PLL

could be useful tools in this respect. For instance, in the case of the Chiang Mai Initiative

Multilateralisation (CMIM) in East Asia, CMIM member countries under current condi-

tions can access only 20 percent of available resources from the CMIM without an IMF

programme. This has led, in effect, to a situation in which the CMIM has not been used,

despite demand for liquidity support during the global financial crisis. To make the CMIM

fully effective and free it from IMF stigma, some argue that this link should be severed as

soon as possible (Sussangkarn 2010; Kawai 2010). However, recognising the FCL/PLL as

a sufficient condition for drawing on the CMIM beyond the first 20 percent would be a

way of maintaining the IMF-CMIM link while allowing CMIM member countries to draw

on the CMIM without needing to enter into a standard IMF programme (cf. Henning 2011;

Volz 2012). Establishing similar linkages with other RFAs could help improve the interac-

tion between RFAs and the Fund on the one hand and make the FCL and PLL more attrac-

tive to member countries on the other.

In order to address the resource issues connected with active promotion of its precaution-

ary facilities, the IMF should be adequately endowed with resources. Moreover, it should

be allowed to leverage its resource endowment by general recognition that contingent fi-

nancing under the FCL needs to be funded with contingent sources of funds for the IMF.

Maintaining a 100 per cent effective financial backup for a facility in which not a single

SDR has been withdrawn under these programmes during a three-year period of great

volatility in the world economy seems unduly restrictive and an unnecessary drain on the

IMF’s regular usable resources. The backing of FCL and PLL arrangements directly

through the expanded NAB should be thoroughly explored. Another potential instrument

to be used as a contingent funding source is the SDR mechanism. Indeed, the SDR could

serve as a backup for the contingent financing provided by the IMF.

Finally, the IMF should continue to seek ways to enhance the attractiveness of the FCL

and PLL, for instance by further prolonging the duration of FCL/PLL programmes in or-

der to give greater certainty to countries and by linking FCL/PLL qualification and review

process more closely to ongoing Fund surveillance.



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60 Hampel-Milagrosa, Aimée: The Role of Regulation, Tradition and Gender in Do-ing Business: Case study and survey report on a two-year project in Ghana, 77 p., Bonn 2011, ISBN 978-3-88985-496-4

59 Weinlich, Silke: Reforming Development Cooperation at the United Nations: An analysis of policy position and actions of major states on reform options, 134 p., Bonn 2011, ISBN 978-3-88985-495-7

58 Chahoud, Tatjana et al.: Corporate Social Responsibility (CSR) and Black Eco-nomic Empowerment (BEE) in South Africa: A case study of German Transna-tional Corporations, 100 p., Bonn 2011, ISBN 978-3-88985-494-0

57 Neubert, Susanne et al.: Agricultural Development in a Changing Climate in Zambia: Increasing resilience to climate change and economic shocks in crop pro-duction, 244 p., Bonn 2011, ISBN 978-3-88985-493-3

56 Grimm, Sven et al.: Coordinating China and DAC Development Partners: Chal-lenges to the aid architecture in Rwanda, 200 p., Bonn 2010, ISBN 978-3-88985-492-6

55 Weinlich, Silke: Die Reform der Entwicklungszusammenarbeit der Vereinten Nati-onen: Eine Analyse des Verhaltens und der Positionierung wichtiger Staaten ge-genüber Reformoptionen, 121 p., Bonn 2010, ISBN 978-3-88985-491-9

[Price: 10,00 Euro; books may be ordered directly from the DIE or through bookshops.]

Discussion Paper

3/2012 Grävingholt, Jörn / Sebastian Ziaja / Merle Kreibaum: State Fragility: Towards a Multi-Dimensional Empirical Typology, 38 p., Bonn 2012, ISBN 978-3-88985-546-6

2/2012 Dafe, Florence: The Politics of Central Banking and Implications for Regula-tory Reform in Sub-Saharan Africa: The cases of Kenya, Nigeria and Uganda, 38 p., Bonn 2012, ISBN 978-3-88985-545-9

1/2012 Weimer, Bernhard: Municipal Tax Base in Mozambique: High Potential – Low Degree of Utilisation, 48 p., Bonn 2012, ISBN 978-3-88985-544-2

14/2011 Stephen Chan OBE: Mercy and the Structures of the World: Third Hans Singer Memorial Lecture on Global Development, 32 p., Bonn 2011, ISBN 978-3-88985-542-8

13/2011 Brandi, Clara / Matthias Helble: The End of GATT-WTO History? – Reflec-tions on the Future of the Post-Doha World Trade Organization, 22 p., Bonn 2011, ISBN 978-3-88985-542-8

[Price: 6,00 Euro; books may be ordered directly from the DIE or through bookshops.]

A complete list of publications available from DIE can be found at: http://www.die-gdi.de

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